Top Glove - UOB Kay Hian 2020-07-17: Management Addresses Withhold Release Order (WRO) By US Customs


Top Glove - Management Addresses Withhold Release Order (WRO) By US Customs

  • We remain sanguine over Top Glove’s near-term prospects. The recent development is likely just a speed bump to its exciting super-cycle earnings growth ahead. The matter of contention is being addressed, leading management to believe it could resolve the WRO by the US authorities within a matter of weeks. Its customers are likely to wait it out, given tight glove supplies, year-long delivery lead times and premium spot prices.
  • Maintain BUY and target price of RM21.90.

Top Glove's conference call to address detention order on glove sales to the US.

  • Top Glove (SGX:BVA) held a conference call with regard to the US Customs and Border Protection (CBP) issuing a Withhold Release Order (WRO), or a detention order, on gloves manufactured by Top Glove. This would restrict the sale of gloves to the US.
  • Here are the key takeaways from Top Glove's conference call:
    • Labour-related. Management gathered that the CBP’s WRO arose from labour-related issues - specifically pertaining to: 1) passport retention by employers; and 2) employees having to bear recruitment fees. CBP’s decision may have been spurred by possible lobbying by non-governmental organisations.
    • Outstanding retrospective recruitment fee. Top Glove believes the issue with CBP lies with the latter as all passports have been returned to its foreign workers. Meanwhile, since Jan 19, recruitment fees have been borne by Top Glove. Thus, the issue herein lies with retrospective recruitment fees which employees had to shoulder prior to Jan 19.
    • To be resolved with an estimated payment of RM20m-50m. That said, Top Glove is in the midst of returning the retrospective outstanding recruitment fees estimated to range between RM20m-50m.
    • Consultant with proven track record has been engaged. Top Glove has engaged the same consultant that successfully removed WRP Asia Pacific, a private listed glove manufacturer from a WRO previously. WRP was issued a WRO in Sep 19 but it was subsequently revoked in Mar 20. WRP’s case was extended for months, in part due to non-payments to its labour force for two months.
    • Looking to be resolved within 2 weeks. Management is confident that the WRO could be resolved in a timely manner and have minimal disruption to sales. Management is targeting a base case timeline of 2 weeks which could be lengthened to a month. The consultant is familiar with Top Glove’s operations and has conducted a recent successful audit, further accelerating the validation process by the consultant.
    • 12.5% sales in question, for now. The two subsidiaries that are under WRO account for half of Top Glove’s US sales or 12.5% of overall volume sales. The remaining US sales are generated from other subsidiaries. Sales to North America could be shored through other subsidiaries and/or could also be channeled to other regions.
    • But management believes customers are willing to wait. Existing inventory under these two subsidiaries are only being withheld at the US ports. They have not been confiscated, but merely stored. Management believes customers would be willing to wait for the WRO to be lifted, given the tight supply of gloves amid an extended delivery lead times of more than a year.

Customers likely to wait it out.

  • Top Glove commands close to a ~20% market share in terms of global examination glove production capacity. Furthermore, long delivery lead times (in excess of a year), sold-out industry capacity (save for marginal incoming supply) and manufacturers opting for a higher spot sales mix leaves Top Glove’s US customers with no other option but to wait until the WRO is lifted. Any termination of sales could simply result in supply being re-designated to spot sales (commands 2-3x higher ASPs).

We remain sanguine over near-term prospects; recent development likely just a speed bump.

  • Given the demand-supply imbalance at this particular juncture and Top Glove’s alternatives in generating sales through other subsidiaries and shifting sales to other regions, we believe Top Glove’s sales are likely to remain firmly intact. There might be a deferred recognition of sales. However, we remain sanguine over Top Glove’s prospects as the labour issue allegations have been a constant revolving theme for the company even despite it successfully undergoing 80-90 audits a year.

No changes to our Top Glove earnings forecasts.

  • Key downside risks include:
    1. swift containment of the COVID-19 outbreak,
    2. disruption to its production or supply chain caused by the COVID-19 outbreak, and
    3. COVID-19 vaccine discovery.
  • That said, Top Glove’s production is spread across 40 sites. Every +1% deviation from our US$4.30/RM assumption translates to a - 2.5% change to our EPS.

Maintain BUY on Top Glove

Philip Wong UOB Kay Hian Research | https://research.uobkayhian.com/ 2020-07-17
SGX Stock Analyst Report BUY MAINTAIN BUY 7.140 SAME 7.140